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The stock market rose last week.
July 2022 saw the best monthly performance for the stock market since 2020.
The S&P 500 was up 9.1 percent in July, the biggest monthly gain since November 2020.
The NASDAQ was up 12.3 percent, the biggest monthly gain since April 2020.
The reason?
Sonal Desai, chief investment officer for fixed income at Franklin Templeton, is quoted in the Financial Times as saying,
“Financial markets heard only what they wanted to hear and ignored the rest.”
And what did some of the investment community hear?
First, the economy is doing very well, thank you.
I captured this mood a couple of days ago as I described some of the economic numbers that analysts have recently been focusing upon.
For example, the industrial production numbers were near historical highs. And capacity utilization is near recent highs.
Furthermore, the unemployment rate, at 3.6 percent is the lowest it has been for decades.
One has to be a little careful with this number as the labor force participation rate has dropped over the past two years to a near-term low.
But these numbers are very encouraging, even though the rate of growth of real GDP came in negative for the second quarter in a row.
Second, earnings results for the corporate world have been coming in better than expected.
Third, longer-term interest rates are expected to fall, even though the Federal Reserve is raising its short-term policy rate of interest.
Market participants seem to be focusing on the plus side here because the term structure of interest rates has inverted and, historically, when this happens, an economic recession usually follows.
Finally, investors focused only on a few of the remarks by Jerome Powell, chairman of the Board of Governors of the Federal Reserve System.
The remarks focused upon related to the fact that Mr. Powell emphasized that he and the other Fed governors were closely watching the data, and if the data indicated that inflationary pressures were weakening, the Fed would certainly alter its policy.
And there you have it. A positive twist to the current economic situation.
The Negative Side
There still are plenty of negatives around…if one wanted to emphasize them.
For one, inflation is still out there along with plenty of information that it will continue at relatively high levels.
And inflation is not just a U.S. problem. Inflation is a problem in Europe and elsewhere in the world.
In addition, there is still a great deal of emphasis upon the fact that the Fed will raise its policy rate of interest several more times, producing more rate increases into at least the middle of 2023.
Furthermore, the Fed has just started to reduce the size of its securities portfolio.
The original plans for this effort indicated that the Fed was picturing this reduction effort would continue into the year 2024.
So, earlier signals showed that Federal Reserve officials saw their current effort extending out for some lengthy time into the future.
Oh, well.
As Mr. Desai is quoted as saying, in the end, the investment community only really hears what it wants to hear.
The Future
In the first half of this year, the stock market produced its worst first-half performance in more than 50 years.
The S&P 500 Stock Index was down by about 21 percent in the first half of 2022. And the NASDAQ was down by 29 percent.
The volatility in the market was quite high.
Uncertainty was all over the place.
And it was only in March that the Fed began to raise its policy rate of interest and it was only in June that the Fed really began to reduce the size of its securities portfolio.
In other words, the Federal Reserve has only really just started to tighten up.
And, the commercial banking system is flush with cash, the consequence of the excessive amount of liquidity that the Fed pumped into the system to fight the Covid-19 pandemic and the short economic recession.
Still, many of the asset bubbles created by the Fed’s largess in 2020 and 2021, are retreating now and we still may see some major corrections in these areas as the deflating of the bubbles continues.
And then there is the Russian invasion of Ukraine.
No one has any idea where this is going or what impact it will have on economies and financial markets throughout the world.
So, the question goes back to the investment community.
Are you really focusing upon the right things?
Personally, I don’t think that you are.
I believe that the Federal Reserve still has some work to do.
I still hope that Mr. Powell and the Federal Reserve keep to their plan and don’t back off at the first cries of pain.
But, by sticking to their plans, the investment community will see the stock market move lower, dropping below the earlier lows achieved this year.
The U.S. economy, as I have written about it, is still very dislocated. These disequilibrium conditions are going to have to be resolved, and given the state of these disequilibrium conditions, I believe that there is substantial pain that will be experienced in the future.
Further declines in the stock market are just one area where this pain will be felt.
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